Aggregate and disaggregate measures of the foreign exchange risk premium

Abstract

Recent proposals for reforming the international monetary system often focus on a target zone arrangement for the dollar, euro and yen. Theoretical research suggests that a credible target zone confers on a participant some short-run discretion in the setting of interest rates, and recent empirical research suggests that this was indeed the case for the Classical gold standard, perhaps the best example of a credible target zone. In this paper we examine the extent of short-run interest rate discretion (SRID) conferred by another experiment with target zones, namely the ERM experience. Amongst our findings is the result that countries that had a credible commitment to the ERM did indeed have SRID.